Simply, Inc. - Quarter Report: 2005 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

 

Washington, D.C. 20549

 

 

FORM 10 - Q

 

 

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.

 

For the quarterly period ended September 30, 2005.

 

005-79915

(Commission File Number)

 

InfoSonics Corporation

(Exact name of registrant as specified in its charter)

 

Maryland		33-0599368
(State or other jurisdiction of incorporation)		(IRS Employer Identification Number)

 

5880 Pacific Center Blvd

San Diego, CA 92121

(Address of principal executive offices including zip code)

 

(858) 373-1600

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former Name or Former Address, if Changed Since Last Report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   ý   No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes   o   No ý

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).
Yes   o   No ý

 

As of November 14, 2005, the Registrant had 5,332,000 shares outstanding of its $.001 par value common stock.

 

 

InfoSonics Corporation

 

Quarterly Report on FORM 10-Q For The Period Ended

 

September 30, 2005

 

Table of Contents

 

PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements
		Consolidated Balance Sheets as of September 30, 2005 (unaudited) and December 31, 2004
		Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2005 (unaudited) and 2004 (unaudited)
		Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 (unaudited) and 2004 (unaudited)
		Notes to Consolidated Financial Statements
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures About Market Risk
Item 4.		Controls and Procedures
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.		Defaults Upon Senior Securities
Item 4.		Submission of Matters to a Vote of Security Holders
Item 5.		Other Information
Item 6.		Exhibits
Signatures
Exhibit 31.1
Exhibit 32.1

 

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Part I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

InfoSonics Corporation and Subsidiaries

Consolidated Balance Sheets

 

		September 30 2005			December 31 2004
		(unaudited)
ASSETS
Current assets
Cash and cash equivalents		$	1,362,640		$	5,183,876
Trade accounts receivable, net of allowance for doubtful accounts of $999,560 (unaudited) and $250,000		36,231,267			7,596,104
Inventory, net of reserves of $140,085 (unaudited) and $141,086		4,863,375			4,640,756
Prepaid inventory		1,389,126			71,850
Prepaid expenses		210,207			384,456
Net assets of discontinued operations		18,413			181,010
Deferred tax assets - current		595,000			285,000
Total current assets		44,670,028			18,343,052
Property and equipment, net		457,984			237,853
Deferred tax assets - noncurrent		8,000			67,000
Intangible asset		504,000
Other assets		89,209			71,851
Total assets		$	45,729,221		$	18,719,756
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Line of credit		$	17,728,275		$	2,564,115
Accounts payable		9,556,977			2,576,034
Accrued expenses		3,235,624			447,054
Income taxes payable		368,880			—
Net liabilities of discontinued operations		—			693,542
Total current liabilities		30,889,756			6,280,745
Stockholders’ equity
Preferred stock, $0.001 par value 10,000,000 shares authorized 0 and 0 shares issued and outstanding		—			—
Common stock, $0.001 par value 40,000,000 shares authorized 5,332,000 shares issued and outstanding		5,332			5,212
Additional paid-in capital		11,033,531			10,529,652
Retained earnings		3,800,602			1,904,147
Total stockholders’ equity		14,839,465			12,439,011
Total liabilities and stockholders’ equity		$	45,729,221		$	18,719,756

 

See accompanying notes.

 

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InfoSonics Corporation and Subsidiaries

Consolidated Statements of Income

(unaudited)

 

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2005			2004			2005			2004
Net sales		$	54,237,278		$	17,393,081		$	110,789,125		$	53,816,308
Cost of sales		50,047,209			16,116,974			101,811,213			49,582,109
Gross profit		4,190,069			1,276,107			8,977,912			4,234,199
Operating expenses		2,970,160			1,076,520			6,517,853			3,114,304
Operating income from continuing operations		1,219,909			199,587			2,460,059			1,119,895
Other income (expense)
Interest income (expense)		(147,301		)	11,759			(233,277		)	(74,356		)
Income from continuing operations before provision for income taxes		1,072,608			211,346			2,226,782			1,045,539
Provision for income taxes		290,478			(117,302		)	704,793			118,633
Income from continuing operations		782,130			328,648			1,521,989			926,906
Income (loss) from discontinued operations net of income tax of $0		391,563			(788,635		)	374,479			(961,344		)
Net income (loss)		$	1,173,693		$	(459,987	)	$	1,896,468		$	(34,438	)
Basic earnings per share
From continuing operations		$	0.15		$	0.06		$	0.29		$	0.23
From discontinued operations		$	0.08		$	(0.15	)	$	0.07		$	(0.24	)
Net Income (loss)		$	0.23		$	(0.09	)	$	0.36		$	(0.01	)
Diluted earnings per share
From continuing operations		$	0.13		$	0.06		$	0.26		$	0.23
From discontinued operations		$	0.07		$	(0.15	)	$	0.06		$	(0.24	)
Net Income (loss)		$	0.20		$	(0.09	)	$	0.32		$	(0.01	)
Basic weighted-average number of common shares outstanding		5,332,000			5,212,000			5,332,000			3,977,197
Diluted weighted-average number of common shares outstanding		5,967,670			5,212,000			5,872,793			3,977,197

 

See accompanying notes.

 

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InfoSonics Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(unaudited)

 

 

See accompanying notes.

 

Non-Cash Supplemental Disclosure

Issuance of common stock for Primasel S.A. acquisition, 120,000 shares valued at $504,000.  See footnote 2 for additional information.

 

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InfoSonics Corporation

Notes to Consolidated Financial Statements

September 30, 2005

 

NOTE 1. Basis of Presentation

 

The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results are likely to differ from those estimates, but management does not believe such differences will materially affect the financial position or results of operations of InfoSonics Corporation (the “Company”). The Consolidated Financial Statements reflect all adjustments considered, in the opinion of the Company, necessary to fairly present the results for the periods. Such adjustments are of a normal recurring nature.

 

The unaudited Consolidated Financial Statements include the accounts of the Company and its subsidiaries, Axcess Mobile LLC, InfoSonics De Mexico, InfoSonics de Guatemala, InfoSonics El Salvador and InfoSonics S.A., all of which are wholly owned. Significant intercompany accounts and transactions have been eliminated in consolidation.

 

The unaudited Consolidated Financial Statements at September 30, 2005 do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. Due to seasonal and other factors, the Company’s interim results may not be indicative of annual results. The unaudited Consolidated Statements of Income for the three months and nine months ended September 30, 2005 and the unaudited Consolidated Statement of Cash Flows for the nine months ended September 30, 2005 are not necessarily indicative of the operating results or cash flows that may be expected for the entire year.

 

The Company has not changed its significant accounting policies from those disclosed in its financial statements as of and for the year ended December 31, 2004 as included in its Form 10-K for the year ended December 31, 2004 that was filed with the Securities and Exchange Commission. For further information, reference is made to the audited Consolidated Financial Statements and the notes thereto included in the Company’s financial statements as of and for the year ended December 31, 2004 as included in its Form 10-K.

 

NOTE 2. Acquisition

 

On January 19, 2005, the Company purchased Primasel S.A., from Fanrock Investments Limited for up to 120,000 shares of the Company’s common stock, based on sales of certain levels being achieved over the course of three years.   Additionally, the Company will pay profit sharing tied to sales and profitability generated by Primasel S.A.  The Company has accounted for the transaction as a stock purchase. Primasel S.A.’s assets at the time of purchase consisted of  a distribution agreement and a management agreement. During the three months ended September 30, 2005, sales levels achieved resulted in the issuance of  120,000 shares of common stock per the terms of the purchase agreement.   As of  September 30, 2005, the Company has recorded the issuance of the shares, as they had been earned, though the shares were not issued until October 2005.  The Company is in the process of allocating the non-cash cost of this issuance between the agreements purchased.    The purchase price has been recorderd as an intangible assets in the accompanying balance sheet.  Additionally,  as of September 30, 2005, the Company has recorded an accrual for profit participation expense in the amount of $627,000.   In February 2005, Primasel S.A. changed its name to InfoSonics S.A.

 

NOTE 3. Discontinued Operations

 

During the quarter ended September 30, 2004, the Company and its Board of Directors discussed Axcess Mobile, LLC and its mall-based kiosk locations and the Company began to implement actions necessary to close those mall-based kiosk locations. On October 28, 2004, the Company assigned the leases for six of the mall-based kiosk locations to an unrelated assignee; however, the assignment did not release the Company from the future lease obligations of up to $994,798. The assignee operates approximately 400 mall-based kiosks in 28 states. A third party is holding in escrow two months rent for the locations from the assignee, and in the event of default by the assignee, those funds will be released to the Company.  The other lease locations were closed in October 2004.  SFAS No. 142, “Goodwill and Other Intangible Assets,” prohibits the

 

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amortization of goodwill, but requires that it be reviewed for impairment at least annually or on an interim basis if an event occurs or circumstances change that could indicate that its value has diminished or been impaired. As a result of the discontinued operation, the Company has reassessed the goodwill and written down the value to zero.  This write-down was recorded as an operating expense in the year ended December 31, 2004. The results of the discontinued operations are as follows

 

 

During the quarter ended Septmeber 30, 2005, the Company was able to resolve outstanding balances with the major vendor for the discontinued operation.  This resolution has been recorded in the current quarter.  As of September 30, 2005 and December 31, 2004, net assets of discontinued operations consist of receivables of $5,000 and $181,000, respectively, and net liabilities of discontinued operations consist of accounts payable of zero and $693,000, respectively.

 

As of September 30, 2005, the actions related to the discontinued operations had been completed, however the Company expects to continue to record adjustments and expenses concerning discontinued operations as necessary.

 

NOTE 4. Stock-Based Compensation

 

The Company has elected to follow APB Opinion No. 25 and related interpretations in accounting for its stock options and grants since the alternative fair market value accounting provided for under Statement of Financial Accounting Standards (SFAS) No. 123 requires use of grant valuation models that were not developed for use in valuing employee stock options and grants. Under APB Opinion No. 25, if the exercise price of the Company’s stock grants and options equals or exceeds the fair value of the underlying stock on the date of grant, no compensation expenses are recognized.

 

If compensation cost for the Company’s stock-based compensation plans had been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, then the Company’s net income for the three months ended and the nine months ended September 30, 2005 and September 30, 2004 would have been adjusted to the pro forma amounts indicated below:

 

		Three Months ended September 30,						Nine Months ended September 30,
		2005			2004			2005			2004
Net income (loss) as reported		$	1,173,693		$	(459,987	)	$	1,896,468		$	(34,438	)
Stock-based employee compensation cost, net of related tax effects, that would have been included in the determination of net income if the fair value method had been applied		(60,748		)	(183,453		)	(572,070		)	(183,453		)
Pro forma		$	1,112,945		$	(643,440	)	$	1,324,398		$	(217,891	)
Basic earnings (loss) per common share as reported		$	0.23		$	(0.09	)	$	0.36		$	(0.01	)
Stock-based employee compensation cost, net of related tax effects, that would have been included in the determination of net income if the fair value method had been applied			(0.01	)		(0.03	)		(0.11	)		(0.03	)
Pro forma		$	0.22		$	(0.12	)	$	0.25		$	(0.04	)
Diluted earnings (loss) per common share
As reported		$	0.20		$	(0.09	)	$	0.32		$	(0.01	)
Stock-based employee compensation cost, net of related tax effects, that would have been included in the determination of net income if the fair value method had been applied			(0.01	)		(0.03	)		(0.10	)		(0.03	)
Pro forma		$	0.19		$	(0.12	)	$	0.22		$	(0.04	)

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NOTE 5. Earnings Per Share

 

The Company utilizes SFAS No. 128, ‘‘Earnings per Share.’’ Basic earnings per share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding. Diluted earnings per share is computed similarly to basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential additional common shares that were dilutive had been issued. Common equivalent shares are excluded from the computation if their effect is anti-dilutive. The Company’s common share equivalents consist of stock options.

 

The following table represents a reconciliation of the shares used to calculate basic and diluted earnings per share for the respective periods indicated:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2005			2004			2005			2004
Numerator: Net Income (loss)		$	1,173,693		$	(459,987	)	$	1,896,468		$	(34,438	)
Denominator:
Denominator for basic earnings per share – weighted average shares		5,332,000			5,212,000			5,332,000			3,977,197
Effect of dilutive securities
Employee stock options		755,670			—			660,793			—
Denominator for diluted earnings per share – adjusted weighted average shares and assumed conversion		5,967,670			5,212,000			5,872,793			3,977,197

 

Potential common shares have been excluded from the computation of diluted earnings per share due to their exercise price being greater than the Company’s weighted average stock price for the period. For the three and nine months ended September 30, 2005, the number of shares excluded were 940,863 and 1,035,407, respectively.  For the three and nine months ended September 30, 2004, all potential common shares were excluded from the calculation since their effect was anti-dilutive.

 

NOTE 6. Income Taxes

 

SFAS No. 109, “ACCOUNTING FOR INCOME TAXES”, establishes financial accounting and reporting standards for the effect of income taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could materially impact our financial position or our results of operations.

 

NOTE 7. Inventory

 

Inventory is valued at the lower of cost or market using standard costs that approximate average cost. Inventories are reviewed periodically and items considered to be slow moving or obsolete are reduced to estimated net realizable value through an appropriate reserve. Inventory consists of the following:

 

		September 30, 2005			December 31, 2004
Finished goods		$	5,003,460		$		4,781,842
Inventory reserve		(140,085		)	(141,086			)
Net inventory		$	4,863,375		$	4,640,756

 

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NOTE 8. Property and Equipment

 

Property and equipment consists of the following:

 

 

Depreciation expense was $59,929 and 31,489 for the nine months ended September 30, 2005 and 2004, respectively.

 

NOTE 9. Revolving Bank Loan Agreements and Notes Payable

 

The Company has a line of credit from a bank, which provides for advances not to exceed 85% of eligible domestic accounts receivable and 70% to 90% of foreign insured accounts, depending on the country of the debtor, up to a maximum of $18,000,000.  The increase from $15,000,000 to $18,000,000 was temporary; in addition, this agreement was terminated October 6, 2005, and replaced with a new credit agreemet from Wells Fargo HSBC Trade Bank (“Wells Fargo”)as described below

 

Interest is payable on a monthly basis at prime (6.75% at September 30, 2005) or at the London Inter-Bank Offering Rate (4.41% at September 30, 2005), plus 2.25% for the first $500,000 and 2.5% for amounts over $500,000. The line of credit is collateralized by substantially all of the assets of the Company, personally guaranteed by the Company’s majority stockholder, who is also our Chief Executive Officer, and expires on July 2006.  Although there are no assurances, we believe that we will be able to extend this revolving line of credit with equal or better terms.  In addition to reporting and other non-financial covenants, the line of credit contains certain financial covenants which require the Company to maintain a tangible net worth of not less than $12,000,000, a quick ratio of not less than 1-to-1, a debt-to-tangible effective-net worth ratio of not greater than 2-to-1, and require the Company to maintain a quarterly net income after taxes of at least $150,000. Management believes the Company was not in compliance with these covenants at September 30, 2005, and this credit agreement was replaced on October 6, 2005. At September 30, 2005 and December 31, 2004, the amounts drawn against the line of credit were $17,728,275 and $2,564,115, respectively.

 

On October 6, 2005, the Company entered into a Credit Agreement (the “Agreement”) with Wells Fargo HSBC Trade Bank, N.A. (“Wells Fargo”) that allows the Company to borrow up to a maximum of $20,000,000 and expires on October 1, 2006.  The Agreement provides for advances not to exceed 80% of eligible domestic accounts receivable and 85% of eligible foreign insured accounts.

 

Interest on the line of credit is payable on a monthly basis at Wells Fargo’s prime rate (6.75% at October 6, 2005) or at the London Inter-Bank Offering Rate (“LIBOR”) plus 1.5% (LIBOR was 4% at October 6, 2005).  The line of credit is collateralized by substantially all of the assets of the Company.  In addition to reporting and other non-financial covenants, the line of credit contains certain financial covenants which, among other items, require the Company to maintain a tangible net worth of not less than $12,000,000, a quick ratio of not less than 1-to-1, a debt-to-tangible net worth ratio of not greater than 2-to-1, to maintain a pre-tax profit of not less than $1 on a rolling four-quarter basis, and to maintain net income after taxes of not less than $1 on an annual basis.  Management believes the Company was in compliance with these covenants at November 14, 2005.  The Company paid the outstanding amount owed under its previous line of credit with funds from the line of credit provided by Wells Fargo. 

 

The Company has no other notes payable.

 

NOTE 10. Stockholders’ Equity

 

Stock Options

 

Effective January 21, 2005 and May 25, 2005 the Company granted options to purchase an aggregate of 335,000 and 39,500 shares, respectively, of its common stock to certain employees, including certain of the Company’s officers (the “Employee Options”). The 335,000 Employee Options vest upon the later of 1) one year after the date on which the employee was hired by the Company; or 2) the date of grant.  The 39,500 Employee Options vest on December 31, 2005. The Employee Options

 

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have an exercise price of $3.29 per share, which was the closing price per share of the Company’s common stock on January 21, 2005.  On May 25, 2005 the stock price was $3.05.  On August 16, 2005 the Company granted options to purchase 25,000 share of its common stock to a certain employee.  These options vest over a period of 2 years from the date of grant.  The employee options have an exercise price of $4.16 which was the closing price on August 16, 2005.  The Employee Options expire three years from the date of grant.

 

Effective January 21, 2005, the Company granted options to purchase 15,000 shares of common stock to each of its three outside board members as consideration for their serving as members of the Board of Directors. These options vest on December 31, 2005 and terminate five years from the date of grant. These options have an exercise price of $3.29 per share, which was the closing price per share of the Company’s common stock on January 21, 2005.

 

NOTE 11. Recent Accounting Pronouncements

 

In March 2005, the FASB issued FASB Interpretation (“FIN”) No. 47, “Accounting for Conditional Asset Retirement Obligations”. FIN No. 47 clarifies that the term conditional asset retirement obligation as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity.  The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement.  Uncertainty about the timing and/or method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists.  This interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN No. 47 is effective no later than the end of fiscal years ending after December 15, 2005 (which would be December 31, 2005 for calendar-year companies). Retrospective application of interim financial information is permitted but is not required.  Management does not expect adoption of FIN No. 47 to have a material impact on the Company’s financial statements.

 

In April 2005, the Securities and Exchange Commission amended the compliance dates to allow companies to implement SFAS No. 123(R) at the beginning of their next fiscal year, instead of the next reporting period, that begins after September 15, 2005, or December 15, 2005 for small business issuers. As a result, SFAS No. 123(R) must be adopted by the Company by the first quarter of 2006.

 

In May 2005, the FASB issued Statement of Accounting Standards (SFAS) No. 154, “Accounting Changes and Error Corrections” an amendment to Accounting Principles Bulletin (APB) Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements” though SFAS No. 154 carries forward the guidance in APB No. 20 and SFAS No. 3 with respect to accounting for changes in estimates, changes in reporting entity, and the correction of errors. SFAS No. 154 establishes new standards on accounting for changes in accounting principles, whereby all such changes must be accounted for by retrospective application to the financial statements of prior periods unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005, with early adoption permitted for changes and corrections made in years beginning after May 2005.

 

NOTE 12. Geographic Information

 

All fixed assest are located in the Company’s offices in the United States.  Revenues by geographical area for the three and nine months ended September 30, 2005 and September 30, 2004:

 

		Three months ended						Nine months ended
		September 30, 2005			September 30, 2004			September 30, 2005			September 30, 2004
United States		$	8,577,711		$	16,608,797		$	35,202,481		$	51,117,177
Argentina		37,651,593			—			56,776,041			—
Latin America		8,097,974			784,284			18,900,603			2,611,394
Europe		—			—			—			87,737
Total		$	54,327,278		$	17,393,081		$	110,789,125		$	53,816,308

 

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition

 

This discussion and analysis should be read in conjunction with the accompanying Consolidated Financial Statements and related notes. Our discussion and analysis of our financial condition and results of operations are based upon

 

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our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent liabilities at the financial statement date, and reported amounts of revenue and expenses during the reporting period. On an ongoing basis we review our estimates and assumptions. Our estimates are based on our historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results are likely to differ from those estimates under different assumptions or conditions, but we do not believe such differences will materially affect our financial position or results of operations. Our critical accounting policies, the policies we believe are most important to the presentation of our financial statements and require the most difficult, subjective and complex judgments, are outlined below in’’—Critical Accounting Policies,’’ and have not changed significantly.

 

In addition, certain statements made in this report may constitute “forward-looking statements”. These forward-looking statements involve known or unknown risks, uncertainties and other factors that may cause the actual results, performance, or achievements of InfoSonics to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Specifically, 1) the actions of competitors and customers and our ability to execute our business plans; and 2) our ability to increase revenues and operating income is dependent upon our ability to continue to expand our current businesses and to enter new business areas, general economic conditions, and other factors. You can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continues” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

 

Overview

 

We are one of the largest distributors of wireless handsets and accessories in the United States and Latin America. We distribute products of several key manufacturers, including Kyocera, LG, Motorola, Nokia, Samsung, VK Mobile, and others. As an integral part of our customers’ supply chain, we perform value added services and customization processes. Our distribution and customization services include the purchasing, marketing, selling, software customization, warehousing, assembly, programming, packing, hardware customization, shipping and delivery of handsets for wireless telecommunications from manufacturers to carriers (wireless network operators), agents, resellers, distributors, independent dealers and retailers in the United States and Latin America.

 

As a part of our distribution activities, we perform value added services when requested by the customer. These services include but are not limited to programming, locking, software loading, packaging, and quality assurance testing. We operate a distribution hub in Miami, Florida.

 

Since our founding in 1994, we have grown our business by focusing on the needs of our customers, developing and maintaining close relationships with manufacturers, entering new markets, and sourcing new and innovative products, while maintaining close attention to operational efficiencies and costs.

 

We successfully completed an initial public offering of our shares of common stock in June 2004 and our common stock is currently traded on the American Stock Exchange under the symbol “IFO”.

 

We also have wholly owned subsidiaries to perform certain functions for some of our Latin American customers, these include InfoSonics De Mexico, InfoSonics de Guatemala, InfoSonics El Salvador and InfoSonics S.A., all of which are wholly owned.  Axcess Mobile, LLC, another of our subsidiaries, is our discontinued operation.  We no longer operate mall-based kiosks and on October 28, 2004, we assigned the leases for six of the mall-based kiosk locations to an unrelated assignee; however, the assignment did not release the Company from the future lease obligations. The assignee operates approximately 400 mall-based kiosks in 28 states. A third party is holding in escrow two months rent for the locations from the assignee, and in the event of default by the assignee, those funds will be released to the Company.  The other lease locations were closed in October 2004.  These subsidiaries are included in our consolidated financial statements and significant inter-company amounts have been eliminated.

 

Due to seasonal and other factors, our interim results may not be indicative of annual results. Our operating results are influenced by several seasonal and other factors, which may cause our revenues and operating results to fluctuate on a quarterly basis, including but not limited to the timing and introduction of new products by our suppliers and competitors, promotions and subsidies by wireless network operators, purchasing patterns of customers, and the timing of holidays and other events affecting consumer demand.

 

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Areas of Management Focus and Performance Indicators

 

We manage our business by focusing on the needs of our customers, developing and maintaining close relationships with manufacturers, entering new markets, and sourcing new and innovative products, while maintaining close attention to operational efficiencies and costs. The desired results of this focus are increased shipping volumes and improved efficiencies to enable higher levels of profitability and earnings growth. Other areas that we focus on include management execution, employee development, customer service, risk management, legal and ethical compliance, and corporate governance.

 

Performance indicators that are key for the monitoring and management of our business include operating and net income, cost of sales and gross profit percentage, operating expenses as a percent of revenues, and overall net sales growth. These items are specifically discussed further in this section. We make extensive use of our customized information system to closely monitor all aspects of our business, including subsidiary performance, customer relationship management, intelligent purchasing, inventory control, inventory flow, line item margin control for every order, and weighted average cost and statistical data for every product, customer and supplier. We believe a strong focus on providing better service to customers leads to increased customer satisfaction and resulting customer retention and potential increases in sales.

 

Management spends a significant amount of time traveling with the purpose of spending time with key customers, suppliers and employees, as well as to identify new business opportunities both in the United States and Latin America. We believe that these relationships are vital to the success of the company and we will continue to dedicate a significant amount of time to this area. We also focus on management execution, quality delivery of services to customers, risk management, and corporate governance.

 

Industry Trends, Challenges, Risks and Growth Opportunities

 

In 2004, worldwide wireless handset sales increased by approximately 31%, and they are forecasted to increase 23% in 2005. A rapid decline in wireless handset sales growth could negatively impact our net sales. Higher than anticipated growth in demand could strain our resources and affect our ability to meet these unanticipated demands.

 

Excess supply conditions can reduce the market prices of the products we sell and therefore affect our ability to generate net sales and gross profit at historical levels and could affect the value of our inventory. Conversely, should manufacturers be unable to respond to an unanticipated increase in demand on a timely basis, we, along with others in our industry, could experience supply constraints that would affect our ability to deliver product. We are unable to quantify these effects, as it is difficult to predict future supply conditions and demand patterns which affect our ability to meet customer demand or sell handsets at an acceptable gross profit.

 

Company Specific Trends, Challenges, Risks and Growth Opportunities

 

For the three months ended September 30, 2005, net sales increased 212% and handsets sold increased 318% compared with the three months ended September 30, 2004. Although we have incorporated growth into our strategic objectives, there can be no assurance these trends will continue. Similarly, while we experienced a 511% increase in income from operations before interest expense and provision for taxes for the three months ended September 30, 2005 and an increase in net income of 355% compared with September 30, 2004, we cannot anticipate future growth to be at the same levels. Our strategy incorporates overall growth elements for each aspect of our business, which we hope will result in continued earnings growth; however, there can be no assurance this trend will continue. Potential investment in growth opportunities and assumed additional risks could alter our earnings trend.

 

Risk Related to Our Business

 

Our operating results may vary significantly, which may cause our stock price to fluctuate.

 

Our operating results are influenced by a number of factors, which may cause our revenue and operating results to fluctuate. These factors include:

 

•                  promotions and subsidy by wireless network operators;

 

•                  the timing of introduction of new products by our suppliers and competitors;

 

•                  purchasing patterns of customers in different markets;

 

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•                  general economic conditions; and

 

•                  product availability and pricing.

 

We buy a significant amount of our products from a limited number of suppliers, who may not provide us with competitive products at reasonable prices when we need them in the future.

 

We purchase wireless handsets and accessories principally from wireless communications equipment manufacturers and distributors. We depend on these suppliers to provide us with adequate inventories of currently popular brand name products on a timely basis and on favorable pricing and other terms. Our agreements with our principal suppliers are non-exclusive, can be terminated on short notice and provide for certain territorial restrictions, as is common in our industry. For the three months ended September 30, 2005 our top three suppliers accounted for 62%, 15% and 11% respectively of our purchases, compared to the three months ended September 30, 2004 during which our top two suppliers accounted for 42%, and 16% respectively of our purchases. Our suppliers may not offer us competitive products on favorable terms or with timely delivery. From time to time, we have been unable to obtain sufficient product supplies. Any failure or delay by our suppliers in supplying us with products on favorable terms may severely diminish our ability to obtain and deliver products to our customers on a timely and competitive basis. If we lose any of our principal suppliers, or if these suppliers are unable to fulfill our product needs, or if any principal supplier imposes substantial price increases and alternative sources of supply are not readily available, it would have a material adverse effect on our results of operations.

 

Our continuing liabilities on leases from our former mall-based retail kiosk locations could have a negative impact on earnings and cash flow.

 

Although we have assigned our six remaining retail leases to a third party and we have received indemnification from the third party, we also remain liable to the lessor, for the respective remaining lease terms of one to three years, if the third party does not fulfill its obligations under the leases. As of December 31, 2004 the total potential liability under these leases was $1,629,520 which is partially offset by a $95,044 escrow deposit held for the benefit of InfoSonics to the extent that the third party should default on any of the assigned leases. This escrow is not reflected on our financial statements. This lease liability is discussed in the footnotes to our consolidated financial statements.

 

The loss or reduction in orders from principal customers or a reduction in prices we are able to charge these customers will have a negative impact upon our revenues and could cause our stock price to decline.

 

Our three largest customers during the three months ended September 30, 2005 accounted for approximately 16%, 14% and 12% respectively, of our product sales. The markets we serve are subject to severe price competition. Additionally, our customers are not contractually obligated to purchase product from us. For these and other reasons such as competitive pricing and competitive pressures, customers may seek to obtain products or services from us at lower prices than we have been able to obtain from these customers in the past. This could occur, for example, in the case of a customer purchasing large quantities of a product from us, who then terminates this relationship because the customer can obtain a lower price by buying directly from the manufacturer. The loss of any of our principal customers, a reduction in the amount of product or services our principal customers order from us or the inability to maintain current terms, including price, with these or other customers could have an adverse effect on our financial condition, results of operations and liquidity. We have experienced losses of certain customers through industry consolidation and ordinary course of business and there can be no assurance that any of our customers will continue to purchase products or services from us or that their purchases will be at the same or greater levels than in prior periods.

 

Our future profitability depends on our ability to maintain existing margins and our ability to increase our sales, which we may not be able to do.

 

The gross margins that we realize on sales of wireless handsets could be reduced due to increased competition or a growing industry emphasis on cost containment. Therefore, our future profitability will depend on our ability to maintain our margins or to increase our sales to help offset potential future declines in margins. We may not be able to maintain existing margins for products or services offered by us or increase our sales. Our ability to generate sales is based upon demand for wireless telecommunications products and our having an adequate supply of these products. Even if our sales rates do increase, the gross margins that we receive from our sales may not be sufficient to make our future operations profitable or as profitable.

 

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Our business depends on the continued tendency of wireless equipment manufacturers and network operators to outsource aspects of their business to us.

 

Our business depends in large part on wireless equipment manufacturers and network operators outsourcing some of their business functions to us. We provide functions such as distribution, inventory management, customized packaging, activation management and other services. Certain wireless equipment manufacturers and network operators have elected, and others may elect, to undertake these services internally. Additionally, our customer service levels, industry consolidation, competition, deregulation, technological changes or other factors could reduce the degree to which members of the wireless telecommunications industry rely on outsourced services such as the services we provide. Any significant change in the market for these services could have a material adverse effect on our current and planned business.

 

We may not be able to effectively compete in our industry if consolidation of wireless network operators continues.

 

The past several years have witnessed a consolidation within the wireless network operator community. If this trend continues, it could result in a reduction or elimination of promotional activities by the remaining wireless network operators as they seek to reduce their expenditures, which could, in turn, result in decreased demand for our products or services. Moreover, consolidation of wireless network operators reduces the number of potential contracts available to us. We could also lose business if wireless network operators, which currently are our customers, are acquired by other wireless network operators which are not our customers. Wireless operators may also change their policy regarding sales to their agents by independent distributors, such as requiring those agents to purchase products from the wireless operator or manufacturer, rather than from distributors such as InfoSonics. This type of requirement could have a material adverse effect on our business and results of operations.

 

Our sales and inventory risk may be materially affected by fluctuations in regional demand patterns and economic factors for which we cannot plan.

 

The demand for our products and services has fluctuated and may continue to vary substantially within the regions served by us. We believe the roll-out of third generation, or 3G, cellular telephone systems and other new technologies, which has been delayed and could further be delayed, has had and will continue to have an effect on overall subscriber growth and handset replacement demand. Economic slow-downs in regions served by us or changes in promotional programs offered by wireless network operators may lower consumer demand for our products and create higher levels of inventories which could decrease our gross and operating margins. We could face a substantial inventory risk due to depreciation and equipment price erosion if our products are not sold in a timely manner. We believe our operations were adversely affected by an economic slow-down in the United States starting in the fourth quarter of 2000. A prolonged economic slow-down in the United States or any other regions in which we have significant operations could negatively impact our results of operations and financial position.

 

We may not be able to adequately respond to rapid technological changes in the wireless telecommunications industry, which could cause us to lose customers.

 

The technology relating to wireless telecommunications equipment changes rapidly resulting in product obsolescence or short product life cycles. We are required to anticipate future technological changes in our industry and to continually identify, obtain and market new products in order to satisfy evolving industry and customer requirements. Competitors or manufacturers of wireless equipment may market products which have perceived or actual advantages over products that we handle or which otherwise render those products obsolete or less marketable. We have made and continue to make significant capital investments in accordance with evolving industry and customer requirements including maintaining levels of inventories of currently popular products that we believe are necessary based on current market conditions. This utilization of capital for inventory buildup of this nature increases our risk of loss due to product obsolescence.

 

Substantial defaults by our customers on accounts receivables could have a significant negative impact on our cash flow and financial condition.

 

We currently offer and intend to offer open account terms to certain of our customers, which may subject us to credit risks, particularly to the extent that our receivables represent sales to a limited number of customers or are concentrated in particular geographic markets. Although we have an accounts receivable insurance policy, this policy carries a substantial deductible and may not cover us in all instances. We also have an accounts receivable credit facility in order to reduce our working capital requirements. The extent of our ability to use our accounts receivable credit facility is dependent on the amount of and collection cycle of our accounts receivable. Adverse changes in our ability to use accounts receivable financing could have a material adverse effect on our financial position, cash flows and results of operations.

 

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We rely on our suppliers to provide trade credit facilities to adequately fund our on-going operations and product purchases, and without those facilities, our ability to procure products could be reduced.

 

Our business is dependent on our ability to obtain adequate supplies of currently popular products on favorable pricing and other terms. Our ability to fund our product purchases is dependent on our principal suppliers providing favorable payment terms that allow us to maximize the efficiency of our capital usage. The payment terms we receive from our suppliers are dependent on several factors, including, but not limited to, our payment history with the supplier, the suppliers’ credit granting policies, contractual provisions, our overall credit rating as determined by various credit rating agencies, industry conditions, our recent operating results, financial position and cash flows and the supplier’s ability to obtain credit insurance on amounts that we owe them. Adverse changes in any of these factors, certain of which may not be wholly in our control, could have a material adverse effect on our operations.

 

Approximately 84% and68% of our revenues during the three and nine months ended September 30, 2005, respectively, were generated outside of the United States in countries that may have political or other risks.

 

We engage in sales activities in territories and countries outside of the United States. The fact that we distribute products into a number of countries exposes us to increased credit risks, customs duties, import quotas and other trade restrictions, potentially greater inflationary pressures, and shipping delays. Changes may occur in social, political, regulatory and economic conditions or in laws and policies governing foreign trade and investment in the territories and countries where we currently distribute products. United States laws and regulations relating to investment and trade in foreign countries could also change to our detriment. Any of these factors could have a material adverse effect on our business and operations. Although we purchase and sell products and services in United States dollars and do not engage in exchange swaps, futures or options contracts or other hedging techniques, fluctuations in currency exchange rates could reduce demand for products sold in United States dollars. We cannot predict the effect that future exchange rate fluctuations will have on our operating results. We may in the future engage in currency hedging transactions, which could result in our incurring significant additional losses.

 

We rely on our information system technology to function efficiently, without interruptions, and if it does not, customer relationships could be harmed.

 

We have focused on the application of our information system technology to provide customized services to wireless communications equipment manufacturers and network operators. Our ability to meet our customers’ technical and performance requirements is highly dependent on the effective functioning of our information technology systems, which may experience interruptions. These business interruptions could cause us to fall below acceptable performance levels pursuant to our customers’ requirements and could result in the loss of the related business relationship.

 

We have outstanding indebtedness, which is secured by substantially all our assets and which could prevent us from borrowing additional funds, if needed.

 

We had outstanding debt in the amount of approximately $17.7 million at September 30, 2005 in the form of a bank line of credit which is based on accounts receivable. If we violate our loan covenants, default on our obligations or become subject to a change of control, our indebtedness would become immediately due and payable. Our credit facility is secured by substantially all of our assets and borrowing availability is based primarily on a percentage of eligible accounts receivable. Consequently, any significant decrease in eligible accounts receivable will limit our ability to borrow additional funds to adequately finance our operations and expansion strategies. The terms of our credit facility could substantially prohibit us from incurring additional indebtedness, which could limit our ability to expand our operations. The terms of our credit facility also include negative covenants that, among other things, limit our ability to sell certain assets and make certain payments, including but not limited to, dividends, repurchases of common stock and other payments outside the normal course of business as well as prohibiting us from merging or consolidating with another corporation or selling all or substantially all of our assets. This facility was replaced by a new facility in October 2005.  The new facilty expires October 2006.

 

The wireless telecommunications industry is intensely competitive and we may not be able to continue to compete against well-established competitors with greater financial and other resources.

 

We compete for sales of wireless telecommunications equipment and accessories, and expect that we will continue to compete, with numerous well-established wireless network operators, distributors and manufacturers, including our own suppliers. Many of our competitors possess greater financial and other resources than we do and may market similar products

 

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or services directly to our customers. Distribution of wireless telecommunications equipment and accessories has generally had low barriers to entry. As a result, additional competitors may choose to enter our industry in the future. The markets for wireless handsets and accessories are characterized by intense price competition and significant price erosion over the life of a product. Many of our competitors have the financial resources to withstand substantial price competition and to implement extensive advertising and promotional programs, both generally and in response to efforts by additional competitors to enter into new markets or introduce new products. Our ability to continue to compete successfully will depend largely on our ability to maintain our current industry relationships. We may not be successful in anticipating and responding to competitive factors affecting our industry, including new or changing outsourcing requirements, the entry of additional well-capitalized competitors, new products which may be introduced, changes in consumer preferences, demographic trends, international, national, regional and local economic conditions and competitors’ discount pricing and promotion strategies. As wireless telecommunications markets mature and as we seek to enter into new markets and offer new products in the future, the competition that we face may change and grow more intense.

 

Our continued growth depends on retaining our current key employees and attracting additional qualified personnel, and we may not be able to continue to do so.

 

Our success depends in large part on the abilities and continued service of our executive officers and other key employees, particularly Joseph Ram, our Chief Executive Officer. Although we have entered into employment agreements with several of our officers and employees, including Mr. Ram, we may not be able to retain their services under applicable law. The loss of executive officers or other key personnel could have a material adverse effect on us. In addition, in order to support our continued growth, we will be required to effectively recruit, develop and retain additional qualified management. If we are unable to attract and retain additional necessary personnel, it could delay or hinder our plans for growth.

 

We rely on trade secret laws and agreements with our key employees and other third parties to protect our proprietary rights, and there is no assurance that these laws or agreements adequately protect our rights.

 

We rely on trade secret laws to protect our proprietary knowledge, particularly our database of customers and suppliers and business terms such as pricing. In general, we also have non-disclosure agreements with our key employees and limit access to and distribution of our trade secrets and other proprietary information. These measures may prove difficult to enforce and may not prove adequate to prevent misappropriation of our proprietary information.

 

We may become subject to suits alleging medical risks associated with our wireless handsets, and the cost of these suits could be substantial, and divert funds from our business.

 

Lawsuits or claims have been filed or made against manufacturers of wireless handsets over the past years alleging possible medical risks, including brain cancer, associated with the electromagnetic fields emitted by wireless communications handsets. There has been only limited relevant research in this area, and this research has not been conclusive as to what effects, if any, exposure to electromagnetic fields emitted by wireless handsets has on human cells. Substantially all of our revenues are derived, either directly or indirectly, from sales of wireless handsets. We may become subject to lawsuits filed by plaintiffs alleging various health risks from our products. If any future studies find possible health risks associated with the use of wireless handsets or if any damages claim against us is successful, it could have a material adverse effect on our business. Even an unsubstantiated perception that health risks exist could adversely affect our ability or the ability of our customers to market wireless handsets.

 

Risks Related To Our Common Stock

 

Stockholders may be diluted as a result of future offerings or other financings.

 

We may need to raise additional capital through one or more future public offerings, private placements or other financings involving our securities. As a result of these financings, none of which is currently planned, ownership interests in our company may be greatly diluted.

 

Our common stock, and our stock price could be volatile and could decline, resulting in a substantial loss on your investment.

 

Prior to our initial public offering in June 2004, there was not a public market for our common stock. An active trading market for our common stock may never develop or be sustained, which could affect the ability of our stockholders to sell their shares and could depress the market price of their shares. The stock market in general and the market for telecommunications-related stocks in particular, has been highly volatile. As a result, the market price of our common stock

 

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is likely to be similarly volatile, and investors in our common stock may experience a decrease in the value of their stock, including decreases unrelated to our operating performance or prospects. The price of our common stock could be subject to wide fluctuations in response to a number of factors, including those listed in this ‘‘Risk Factors’’ section of this Form 10-Q. In the past, securities class action litigation has often been instituted against companies following periods of volatility in their stock price. This type of litigation against us could result in substantial costs and divert our management’s attention and resources.

 

Shares of common stock that are issuable pursuant to our stock option plans and our outstanding warrants, when issued, could result in dilution to existing stockholders and could cause the market price of our common stock to fall.

 

We have reserved shares of common stock that may be issuable pursuant to our stock option plans and our outstanding options outside those plans. These securities, when issued and outstanding, may reduce earnings per share under accounting principles generally accepted in the United States of America and, to the extent that they are exercised and shares of common stock are issued, dilute percentage ownership to existing stockholders which could have an adverse effect on the market price of our common stock.

 

The ability of our stockholders to control our policies or effect a change in control of our company is limited, which may not be in our stockholders’ best interests.

 

Some provisions of our charter and bylaws and the General Corporation Law of Maryland, where we are incorporated, may delay or prevent a change in control of our company or other transactions that could provide our common stockholders with a premium over the then-prevailing market price of our common stock or that might otherwise be in the best interests of our stockholders. These include the ability of our Board of Directors to authorize the issuance of preferred stock without stockholder approval, which preferred stock may have voting provisions that could delay or prevent a change in control or other transaction that might involve a premium price or otherwise be in the best interests of our stockholders. Maryland law imposes restrictions on some business combinations and requires compliance with statutory procedures before some mergers and acquisitions can occur. These provisions of Maryland law may have the effect of discouraging offers to acquire us even if the acquisition would be advantageous to our stockholders.

 

If our two largest stockholders have strategic interests that are similar and that differ from those of our other stockholders, and if those two stockholders vote in the same manner, they may be able to cause results that the other stockholders do not believe to be beneficial to their interests.

 

Two of our stockholders, in the aggregate, beneficially own approximately 61.6% of our outstanding common stock. To the extent that these stockholders vote their shares similarly, they will be able to exercise control over many matters requiring approval by the board of directors or our stockholders. As a result, they would be able to:

 

•                  control the composition of our board of directors;

 

•                  control our management and policies;

 

•                  determine the outcome of significant corporate transactions, including changes in control that may be beneficial to stockholders; and

 

•                  act in their mutual interests, which may conflict with, or be different from, the interests of other stockholders.

 

Available Information

 

Our website at www.infosonics.com provides a link to the Securities and Exchange Commission’s website where our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K (including exhibits and supplementary schedules) and amendments to those reports, filed or furnished under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, can be accessed free of charge.

 

Results of Operations:

 

Three months ended September 30, 2005 compared with three months ended September 30, 2004

 

Net sales for the three months ended September 30, 2005 were $54.2 million, compared with $17.4 million for the

 

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three months ended September 30, 2004, an increase of 212%. The increase in net sales is primarily due to a 318% increase in units sold, which was partially offset by a 25% decrease in average unit selling price compared to the three months ended September 30, 2004. The significant progress the Company has made selling directly to the cellular carriers in the Untied States and Latin America is directly responsible for the increased sales, both in dollars and units sold.  Net sales from Argentina and Latin America increased to $45.7 million for the three months ended September 30, 2005, as compared with $0.8 million for the three months ended September 30, 2004. This increase is primarily the result of our acquisition in Argentina which was completed in January 2005, in addition to increased personnel and selling efforts in Latin America.  Revenues in the United States were $8.6 million for the three months ended September 30, 2005 as compared with $16.6 million for the three months ended September 30, 2004.  This decrease is primaruliy a result of our shift in sales focus in the U.S. sales from the dealer/agent channel to rural U.S. carriers, and the resulting sales to rural U.S. carriers have not been sufficient to offset our decline in sales to U.S. dealer/agents.

 

Cost of sales for the three months ended September 30, 2005 was $50.0 million, or 92.3% of net sales, compared with $16.1 million, or 92.7% of net sales, for the three months ended September 30, 2004. The $33.9 million (211%) increase in cost of sales is consistent with our 212% increase in net sales.

 

Gross profit for the three months ended September 30, 2005 was $4.2 million, or 7.7% of net sales, compared with $1.3 million, or 7.3% of net sales, for the three months ended September 30, 2004. The 5% increase in gross profit percentage from 7.3% to 7.7% represents a shift in products with higher gross margin opportunity during the three months ended September 30, 2005 as compared with the three months ended September 30, 2004.

 

Operating expenses for the three months ended September 30, 2005 were $3.0 million, or 5.5% of net sales, compared with $1.1 million, or 6.2% of net sales, for the three months ended September 30, 2004. The $1.9 million increase is primarily due to expenses related to 1) increased investments in infrastructure due to expenses in obtaining type approval certification from key carrier customers in the United States and in Latin America, 2) being a public company and 3) our expanded operations in Latin America, all of which have contributed to our increased sales levels. We now also occupy larger office and warehouse facilities. The decrease in operating expenses as a percentage of revenues is related to the factors discussed above, and our ability to take advantage of efficiencies in our operations as we continue to grow.

 

Income from continuing operations before interest expense and provision for income taxes for the three months ended September 30, 2005 was $1.2 million, representing an increase of 511% compared to the three months ended September 30, 2004. As a percentage of net sales, income from operations was 2.2% for the three months ended September 30, 2005 compared with 1.1% for the three months ended September 30, 2004. This increase in income from continuing operations both in dollars and as a percentage of net sales, is the result of increased sales volumes, increased gross margin and gross profit and our operational efficiencies achieved.

 

For the three months ended September 30, 2005, we had a gain from discontinued operations of $392,000, or $.07 per share, as compared with a loss of $788,000, or $.15 per share, for the three months ended September 30, 2004.  The gain during the quarter ended September 30, 2005 is a result of the resolution of outstanding accounts with a former supplier for the discontinued operations.  This supplier is not involved with our continuing operations.

 

Net income for the three months ended September 30, 2005 was $1.2 million or $0.20 per diluted share, compared to net loss of $460,000, or $0.09 per diluted share, for the three months ended September 30, 2004, representing a dollar increase of $1.6 million The increase in net income is primarily due to increased net sales and increased gross profits, as well as the gain from discontinued operations.

 

Nine Months Ended September 30, 2004 Compared with Nine Months Ended September 30, 2005

 

Net sales for the nine months ended September 30, 2005 were $110.8 million, compared with $53.8 million for the nine months ended September 30, 2004, an increase of 106%. The increase in net sales is primarily due to a 140% increase in units sold, which was partially offset by a 14% decrease in average unit selling price compared to the nine months ended September 30, 2004. The first nine months of 2005 have begun to show results for the efforts and focus the Company has had with the rural carriers in the United States and the Latin American carriers.  Net sales from Argentina and Latin America increased to $75.7 million for the nine months ended September 30, 2005, as compared with $2.6 million for the nine months ended September 30, 2004. This increase is primarily the result of our focused efforts in Latin America during the first nine months of 2005, which included our acquisition in Argentina which was completed in January 2005, as well as increased personnel and selling efforts in Latin America.  Revenues in the United States were $35.2 million for the nine months ended September 30, 2005 as compared with $51.1 million for the nine months ended September 30, 2004. This decrease was primarily due to our shifting our U.S. sales focus from the dealer/agent channel to rural carriers in the United States, and the

 

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resulting sales to these carriers not being at a level sufficient to offset our decline in sales to the dealer/agents in the United States.

 

Cost of sales for the nine months ended September 30, 2005 was $101.8 million, or 91.9% of net sales, compared with $49.6 million, or 92.1% of net sales, for the nine months ended September 30, 2004. The $52.2 million (105%) increase in cost of sales is consistent with our 106% increase in net sales.

 

Gross profit for the nine months ended September 30, 2005 was $9.0 million, or 8.1% of net sales, compared with $4.2 million, or 7.9% of net sales, for the nine months ended September 30, 2004. The 3% increase in gross profit percentage from 7.9% to 8.1% is primarily due to our shift in sales to rural carriers in the United States as well as sales to carriers sales in Latin America for the nine months ended September 30, 2005, as compared with the nine months ended September 30, 2004 when sales were primarily to dealer agents.  In addition products with higher margin opportunity were available during the nine months ended September 30, 2005.

 

Operating expenses for the nine months ended September 30, 2005 were $6.5 million, or 5.9% of net sales, compared with $3.1 million, or 5.8% of net sales, for the nine months ended September 30, 2004. The $3.4 million increase is primarily due to expenses related to 1) increased investments in infrastructure due to expenses in obtaining type approval certification from key carrier customers in the United States and in Latin America, 2) being a public company for the entire period of 2005 and 3) our expanded operations in Latin America, all of which have contributed to our increased sales levels. We now also occupy larger office and warehouse facilities. The increase in operating expenses as a percentage of revenues is related to the factors discussed above.

 

Income from continuing operations before interest expense and provision for income taxes for the nine months ended September 30, 2005 increased to $2.5 million from $1.1 million for the nine months ended September 30, 2004, representing an increase of 120%. As a percentage of net sales, income from continuing operations was 2.2% for the nine months ended September 30, 2005 compared with 2.0% for the nine months ended September 30, 2004. This increase in income from continuing operations both in dollars and as a percentage of net sales, is the result of increased sales volumes, increased gross profit and gorss margin and our ability to take advantage of efficiencies in our operations as we continue to grow.

 

For the nine months ended September 30, 2005, we had a gain from discontinued operations of $380,000, or $.06 per share, as compared with a loss of $961,000, or $.24 per share, for the nine months ended September 30, 2004.  The gain during the nine months ended September 30, 2005 is a result of the resolution of outstanding accounts with a former supplier for the discontinued operations.  This former supplier is not involved with our continuing operations.

 

Net income for the nine months ended September 30, 2005 was $1.9 million or $0.32 per diluted share, compared to net loss of $34,000, or $0.01 per diluted share, for the nine months ended September 30, 2004, representing a dollar increase of $1.9 million. The increase in net income is primarily due to increased net sales, increased gross profits and gross margins, the gain from discontinued operations as well as increased operational efficiencies achived during the nine months ended September 30, 2005.

 

Financial Condition, Liquidity and Capital Resources

 

Cash and Cash Flows

 

At September 30, 2005, we had cash and cash equivalents of $1.4 million, and at December 31, 2004, we had cash and cash equivalents of $5.2 million.

 

During the quarter ended September 30, 2005, we continued to leverage our bank and vendor lines of credit to help fund our growth. The net cash used by operating activities was $18.5 million for the nine months ended September 30, 2005, increased borrowings from our line of credit and vendor partners to fund product purchases for increased sales and which resulted primarily from increased accounts receivable. The $29.4 million increase in accounts receivable was due to increased sales in the quarter ended September 30, 2005. Allowance for doubtful accounts at September 30, 2005 increased to $1.0 million compared to $250,000 at December 31, 2004. This increase was related to our increased sales levels and increased accounts receivable balance at September 30, 2005. We believe that at September 30, 2005, our reserve for doubtful accounts is adequate.  The increase of cash used in operations related to accounts receivable was partially offset by an increase in our accounts payable of $7.0 million, and an increase in accrued expenses of $2.8 million, which were both a direct result of increasing lines of credit from our vendor partners.

 

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Days’ sales outstanding at September 30, 2005 was 53 days compared with 40 days at December 31, 2004. Normal payment terms require our customer payment on a net 30-day basis and during the quarter ended September 30, 2005 we had a large amount of sales occur towards the end of the quarter, resulting in a higher accounts receivable amount,, subsequent to September 30, 2005, approximately $32 million was collected thru November 10, 2005. We are constantly working with our customers to reduce our days’ sales outstanding.

 

The net cash used in investing activities was $280,000 for the nine months ended September 30, 2005 compared with $200,000 for the nine months ended September 30, 2004. The cash used in the period ended September 30, 2005 was primarily the result of expenditures for machinery and equipment to support technical capabilities and assembly machines and increased warehouse and facility space, as well as the technical tools and equipment necessary for the testing, repair and customization process.

 

The net cash provided by financing activities for the nine months ended September 30, 2005 of $15.2 million is the result of borrowings from our bank line of credit.

 

Our tangible net worth at September 30, 2005 was $14.8 million, compared with $12.4 million at December 31, 2004. This change was due primarily to our increased net income for the nine months ended September 30, 2005.

 

Borrowings

 

We utilize a bank line of credit that is based upon eligible accounts receivable. As of September 30, 2005 and December 31, 2004, amounts advanced against our line were approximately $17,700,000 and $2,600,000, respectively. This credit line has been an important part of growing our business, and market changes affecting accounts receivable could diminish the borrowing base of available funds. As of September 30, 2005 and December 31, 2004, advances were 98% and 47%, respectively, of the available borrowing base.

 

On October 6, 2005, the Company entered into a Credit Agreement (the “Wells Fargo Agreement”) with Wells Fargo HSBC Trade Bank, N.A. (“Wells Fargo”) that allows the Company to borrow up to a maximum of $20,000,000 and expires on October 1, 2006.  The Wells Fargo Agreement provides for advances not to exceed 80% of eligible domestic accounts receivable and 85% of eligible foreign insured accounts.

 

Interest on the line of credit is payable on a monthly basis at Wells Fargo’s prime rate (6.75% at October 6, 2005) or at the London Inter-Bank Offering Rate (“LIBOR”) plus 1.5% (LIBOR was 4% at October 6, 2005).  The line of credit is collateralized by substantially all of the assets of the Company.  In addition to reporting and other non-financial covenants, the line of credit contains certain financial covenants which, among other items, require the Company to maintain a tangible net worth of not less than $12,000,000, a quick ratio of not less than 1-to-1, a debt-to-tangible net worth ratio of not greater than 2-to-1, to maintain a pre-tax profit of not less than $1 on a rolling four-quarter basis, and to maintain net income after taxes of not less than $1 on an annual basis.  Management believes the Company was in compliance with these covenants at November 14, 2005.  The Company paid the outstanding amount owed under its previous line of credit with funds from the line of credit provided by Wells Fargo.  As of November 11, 2005, our net availability on the maximum borrowing amount as of that date was approximately $XX million.

 

We believe that our existing cash resources, together with our projected cash flow from operations and the net proceeds from our bank line of credit, will be sufficient to allow us to implement our strategy and growth plan.

 

Critical Accounting Policies

 

We believe the following critical accounting policies are important to the presentation of our financial condition and results, and require management’s judgments often as a result of the need to make estimates about the affect of matters that are inherently uncertain.

 

Revenue Recognition and Accrued Chargebacks

 

Revenues are recognized upon (1) shipment of the products to customers, (2) when collection of the outstanding receivables is probable, and (3) the final price of the product is determined. Commission revenue, paid by the carrier, on phone activations is recorded at the time of the activation and may be charged back to us in future periods. Commission revenue and accrued chargebacks are related to our discontinued operations. The carrier has six months from date of activation to charge back amounts previously credited to us if the customer terminates its service. We provide an allowance

 

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for estimated returns based on our experience, which estimate is recorded as a contra asset against accounts receivable. A provision for returns is provided in the same period in which the related revenue is recorded. Customer credit-worthiness and economic conditions may change and increase the risk of collectibility and contract terminations and may require additional provisions, which would negatively impact our operating results.

 

Allowance for Doubtful Accounts and Sales Return Reserve

 

Credit evaluations are undertaken for all major sale transactions before shipment is authorized. Normal payment terms require payment on a net ninety-day basis. On an on-going basis, we analyze the payment history of customer accounts, including recent customer purchases. We evaluate aged items in the accounts receivable aging and provide reserves for doubtful accounts and estimated sales returns. Customer credit-worthiness and economic conditions may change and increase the risk of collectibility and sales returns, and may require additional provisions, which would negatively impact our operating results.

 

Inventory Write-Off and Effect on Gross Margin

 

We regularly monitor inventory quantities on hand and record a provision for excess and obsolete inventories based primarily on historical usage rates and our estimated forecast of product demand for a period of time, which is generally nine months. Because of obsolescence, we will generally provide a full reserve for the costs of our inventories in excess of our relevant forecast for the applicable period. We attempt to control our inventory levels so that we do not hold inventories in excess of demand for the succeeding nine months. However, because we need to place non-cancelable orders with significant lead time and because it is difficult to estimate product demand, it is possible that we will build inventories in excess of demand for the future periods. If we have inventories in excess of estimated product demand, we will provide a reserve, which could have a material adverse effect on our reported results of operations and financial position.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

We are subject to market risks with respect to interest rates because our lines of credit have had floating interest rates. As of September 30, 2005 we could choose among the bank’s prime rate, which was 6.75% at September 30, 2005, and the one-, two-, and three-month LIBOR rates plus 2.25% for the first $500,000 of borrowings and plus 2.5% for borrowing above $500,000. As of September 30, 2005, our borrowings were all at the bank’s prime rate. If the full $18,000,000 available under our credit facility were outstanding for a full year, each increase of 1% in the applicable interest rate would result in an additional $180,000 in interest expense for that year.  As more fully described above under “Borrowings”, we replaced our line of credit facility in October 2005.

 

Our business outside the United States is conducted in United States dollars. Although we purchase and sell products and services in United States dollars and do not engage in exchange swaps, futures or options contracts or other hedging techniques, fluctuations in currency exchange rates could reduce demand for products sold in United States dollars. We cannot predict the effect that future exchange rate fluctuations will have on our operating results. We believe our exposure to market risks, including exchange rate risk, interest rate risk and commodity price risk, is not material at the present time. We may in the future engage in currency hedging transactions, which could result in our incurring significant additional losses.

 

Item 4. Controls and Procedures

 

As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on this evaluation, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission (“SEC”) rules and forms. There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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The Company is a non-accelrated filer and is required to comply with the internal control reporting and disclosure requirements of Section 404 of the Sarbanes-Oxley Act for fiscal years ending on or after July 15, 2007.  The Company is currently beginning the documentation phase of its Section 404 compliance and will be required to comply with these disclosure requirements for it fiscal year ending December 31, 2007.

 

PART II. OTHER INFORMATION

 

Item 1.           Legal Proceedings

 

The Company may become involved in certain legal proceedings and claims which arise in the normal course of business. As of September 30, 2005, the Company did not have any significant litigation outstanding, and management does not expect any pending litigation matters to have a material impact on the Company’s liquidity or the financial statements taken as a whole.

 

Item 2.           Unregistered Sales of Equity Securities and Use of Proceeds.

 

Effective August 16, 2005, the Company issued options to purchase 25,000 shares of common stock to certain employees (the “Employee Options”).  The Employee Options vest over a two year period from the date of option grant (August 16, 2005) and have an exercise price of $4.16 per share, which was the closing price per share of the Company’s common stock on August 16, 2005. The Employee Options expire three years from the date of grant.  These grants were made pursuant to exemptions from registration under the Securities Act of 1933, including but not limited to Section 4(2) of the Securities Act of 1933.

 

On January 19, 2005, the Company purchased InfoSonics S.A (formerly Primasel S.A) from Fanrock Investments Limited for up to 120,000 shares of InfoSonics common stock, based on sales of certain levels being achieved in the next three years.  During the three months ended September 30, 2005, InfoSonics S.A. achieved sales levels that obligated the Company to issue 120,000 shares of it’s common stock to Fanrock, and these shares were issued October 7, 2005.  The issuance of these shares was made pursuant to exemptions from registration under the SecuritiesAct of 1933, including but not limited to Section 4(2) of the Securities Act of 1933.

 

Item 3.           Defaults Upon Senior Securities.

 

None.

 

Item 4.           Submission of Matters to a Vote of Security Holders.

 

The following matter were submitted to a vote of security holders at the annual meeting of stockholders which was held on August 5, 2005.

 

The stockholders voted to re-elect Josh Ram, Abraham G Roseler, Randall Marx, Robert S Picow and Kirk A Waldron to coniue as directors of the Company.  A total of      votes were represented with respect to this matter, with voting on each specific nominee as follows:

 

		FOR		WITHHELD
Joseph Ram		4,950,939		165,325
Abraham G. Rosler		4,932,039		184,225
Randall P. Marx		4,932,039		184,225
Robert S. Picow		4,950,939		165,325
Kirk A. Waldron		4,950,939		165,325

 

A proposal to ratify the employment of Singer Lewak Greenbaum & Goldstein LLP as the Company’s independent auditor for fiscal year ending December 31, 2005 was approved by the stockholders.  A total of 5,116,264 votes were represented with a total of 5,098,014 (99.6%) shares voting for the proposal, 18,200 shares voting against the proposal, and 50 shares abstaining from voting.

 

A proposal to amend our 2003 Stock Option Plan to increase from 775,000 to 1,400,000 the number of shares of common stock issuable pursuant to options granted under our 2003 Stock Optin Plan was approved by stockholders.  A total

 

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of 5,116,264 votes were represented with a total of 3,336,327 (65.2%) shares voting for the proposal, 247,712 shares voting against the proposal, and 8,000 shares abstaining from voting.

 

Item 5.           Other Information.

 

None.

 

Item 6.           Exhibits

 

31.1		Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

			InfoSonics Corporation
Date:	November 14, 2005	By:	/S/ Joseph Ram
			Joseph Ram
			Chief Executive Officer
Date:	November 14, 2005	By:	/S/ Jeffrey Klausner
			Jeffrey Klausner
			Chief Financial Officer

 

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